Fintech is a relatively new buzzword. By definition it is the application of technology to solve financial problems and in that sense, it is not new.

Since the 1960s it has been shaping and reshaping finance through the advent of credit cards, bank computerization, and localized banking through ATMs. Currently the gamut of fintech services is not limited to only banking and payment services but cut across the entire service spectrum of finance.

If we consider financial systems and problems faced by the system, these issues stand out:

• How do buyers know about the sellers?
• How does a lender get to know the borrower and vice versa?

There is a huge searching cost. In the olden days, brokers or intermediaries would solve this problem by matchmaking/ brokering between suitable counterparties in exchange for a commission.

Additional issues are the contracting and transaction costs. The transaction cost will be lower only if there is stiff competition among the intermediaries.

We next come to risk sharing. If one lender lends to only one borrower, then the risk is far higher than if it were to multiple borrowers.

Last but not the least is information asymmetry. The lender has inadequate information about the borrower. The lender cannot anticipate every action or motive of the borrower. If the borrower willfully defaults, also called moral hazard, the lender loses money. In a world of sparse and expensive information, sourcing more information on the lender adds to the monitoring cost.

Applications of digital technology in finance or fintech aim to overcome these challenges. Fintech acts as a non-human intermediary delivering accurate results at an optimum cost.

Let us take the case of a peer-to-peer (P2P) lending fintech to understand how fintech reduces the impact of the aforesaid problems.

Thanks to Web 2.0 and social networking, fintech brings together buyers and sellers of securities or lenders and borrowers into one marketplace where matchmaking can be easily done.

In this scenario, a lender can cherry pick from among borrowers and even share the risk across multiple borrowers. The efficient bid-ask process with higher participation brings much-needed liquidity into the process with a lower transaction cost.

The cost of contracting can be made simpler by using technology. Pre-written contracts can be digitally signed by both parties once their KYC credentials are digitally embedded in the contract. The elaborate process of procuring stamp paper from the court, printing a contract document, and registering it with the help of a lawyer becomes redundant.

Once the searching cost and transaction costs are minimized, a lender can easily lend to many borrowers cheaply, aiding risk sharing. This will minimize the default risk faced by the lenders.

Monitoring with technology becomes easier. A P2P lending fintech will have on record, lender & borrower profiles, KYC verification, user generated credit ratings etc. This can be shared with other users by the lender or more importantly the borrower.

Before deciding to dine at a restaurant or buy a product on an ecommerce site, we check the user ratings. In the same way credit ratings of a borrower can be checked before lending.

A smart lender can also use the demand-supply gap by lending to lower rated borrowers at higher rates and making more money. Since ratings are public and defaults can result in costlier loans in future or no loans at all, the chance of willful defaults or moral hazard will be lesser.

Just like social monitoring in rural microfinance, monitoring by fintech social media can potentially reduce the chance of default. Hence monitoring will be easy and at minimal cost. Since the outcome of monitoring will be shared with all participants, the available information will reduce the asymmetric information problem.

To conclude, we must consider that peer-to-peer lending fintech is not yet recognised legally by RBI. But in the years to come many similar fintech organizations like crowdfunding, crowd-investment, start-up-funding, farmer-finance & MSME finance will come up.

India being a country where financial inclusion is low may even become a hotbed for such experiments. However, those apps must solve one or many of the above-mentioned problems, which are searching cost, transaction cost, risk sharing, asymmetric information, and monitoring cost.

Employment opportunities will open up in the fintech sector in two interlinked ways. People with new ideas will try to create new fintech solutions to solve existing gaps. On the other hand, there would be a need for resources with technical expertise who will build the actual solution and applications.

Dr Sayantan Kundu is an Associate Professor of Praxis Business School. Praxis Business School offers specializations in Project Financing and Credit Risk Management as part of their two year PGDM program. The emphasis is on creating Finance professionals who can leverage technology to create new age solutions for a digital world."

This article has been produced on behalf of Praxis Business School by ABP Digital Brand Studio.